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Draft Code 12: Contribution Notices: Circumstances in relation to the material detriment test, the employer insolvency test and the employer resources test

This code is currently in draft form

Introduction

1. This code of practice sets out the circumstances in which we expect to issue a contribution notice (CN), where we believe that the material detriment test, the employer insolvency test or the employer resources test has been met.

2. The publication of this code is a statutory requirement and has been produced under the power given to us in section 90 of the Pensions Act 2004.


Status of the code

3. When considering issuing a CN under the material detriment, employer insolvency or employer resources tests, we will take the relevant part of this code into account.

4. This code is admissible in evidence in any legal proceedings and must be taken into account by a court or tribunal where it is relevant to any question arising in those proceedings. It is not, however, a statement of the law.


Using this code

5. This code should be read in conjunction with Part 1 of the Pensions Act 2004 (as amended). In this code, unless stated otherwise, all statutory references are to the Pensions Act 2004 (as amended).


TPR’s other functions

6. The circumstances in this code do not relate to our other functions.


Northern Ireland

7. In this code, references to the law that applies in Great Britain should be taken to include corresponding legislation in Northern Ireland. Appendix B to this code lists the corresponding references.

Material detriment test

8. In order to issue a CN by reference to the material detriment test, we must be of the opinion that:

  • the act has been materially detrimental to the likelihood of the accrued scheme benefits being received (whether the benefits are to be received as benefits under the scheme or otherwise)1, considering all relevant factors2, and
  • the statutory defence3 is not met

Employer insolvency test

9. In order to issue a CN by reference to the employer insolvency test, we must be of the opinion that:

a. immediately after the relevant time, the value of the assets of the scheme was less than the amount of the liabilities of the scheme4, and
b. if a debt under section 75(4) of the Pensions Act 1995 had fallen due from the employer to the scheme immediately after the relevant time, the act would have materially reduced the amount of the debt likely to be recovered by the scheme5, and
c. the statutory defence6 is not met in relation to the act

10. For the purposes of this test:

a. The value of the assets of the scheme immediately after the relevant time is the value estimated by us.
b. The value of the liabilities of the scheme immediately after the relevant time is the value estimated by us.
c. The amount of the debt that would have fallen due immediately after the relevant time is the amount estimated by us.
d. The value of scheme assets and liabilities, and the value of any debt due under section 75(4) of the Pensions Act 1995, must be estimated according to how assets and liabilities, and their value or amount, are determined and calculated for the purposes of section 75(4) of the Pensions Act 1995.
e. When estimating these values, we must disregard the amount of any debt due immediately after the relevant time from the employer under section 75 of the Pensions Act 1995.

Footnotes for this section

  • [1] See section 38A(1)
  • [2] See section 38A(4)
  • [3] See section 38B
  • [4] See section 38C(1)(a)
  • [5] See section 38C(1)(b)
  • [6] See section 38D

Employer resources test

11. In order to issue a CN by reference to the employer resources test, we must be of the opinion that:

a. the act reduced the value of the resources of the employer7, and
b. that reduction was a material reduction relative to the estimated section 75 debt in relation to the scheme8, and
c. the statutory defence9 is not met in relation to the act.

12. What constitutes the “resources of the employer” must be determined, and their value must be determined, calculated and verified, according to the method prescribed in legislation10.

13. The “estimated section 75 debt” is the amount we estimate would become due from the employer to the scheme trustees under section 75 of the Pensions Act 1995 at the relevant time, disregarding any actual debt due at that time.


The circumstances

14. Below is a list of circumstances in which we expect to issue a CN if we are of the opinion that one or more of the tests discussed in this code could be met11:

  1. Sponsor support is removed, substantially reduced or becomes nominal (any of the tests)
  2. Weakening of the scheme’s creditor position (material detriment and/or employer insolvency)
  3. Some instances of paying a dividend or a return of capital by the sponsoring employer (any of the tests)
  4. Payments favouring other creditors of the employer over the scheme where no such sums are then due to those creditors (any of the tests)

15. However, a CN may only be issued if it is reasonable to impose liability on the person to pay the sum specified in the notice, having regard to:

  • the extent to which, in all the circumstances of the case, it was reasonable for the person to act, or fail to act, in the way that the person did12, and
  • such other matters as the regulator considers relevant13.

16. It is possible for the ‘act’ test (e.g. the material detriment test, the employer insolvency test or the employer resources test) to be met, but for the Regulator to conclude that it is not reasonable to issue a CN in the circumstances.

Footnotes for this section

  • [7] See section 38E(1)(a)
  • [8] See section 38E(1)(b)
  • [9] See section 38F
  • [10] See The Pensions Regulator (Contribution Notices) (Amendment) Regulations 2021
  • [11] These circumstances are not mutually exclusive, eg there is some overlap between the weakening of sponsor support in circumstance 1, and paying a dividend in circumstance 3
  • [12] See section 38(3)(d)
  • [13] Including (where relevant) the matters falling within section 38(7)

Code-related guidance

Code in force: October 2021

Introduction

These examples illustrate how the material detriment test, the employer resources test or the employer insolvency test for CNs and the Code of practice No. 12 'Circumstances in relation to the material detriment, employer insolvency or employer resource test' might be considered in practice.

Points to note

We have produced these examples for illustrative purposes only. They should not be considered as setting precedents as they are not exhaustive and do not illustrate all instances where we may or may not act.

The decision to pursue a CN on the basis that any of these tests is met is subject to a series of legislative conditions and procedural safeguards, and the examples below consider facts in isolation from other potential material factors which may influence our conclusions.

Please note that some of the situations below which are described as not normally meeting any of the tests may, when taken together with other acts, constitute a series of acts which does (as a whole) meet the relevant test for issuing a CN.

We may also choose to run more than one case in the alternative, for example, on the basis that the employer resources test is met or, in the alternative, because the material detriment test is met.

We have a wide range of powers which we will use appropriately and proportionately. Even where we are pursuing a case in which the material detriment, the employer resources or the employer insolvency test would be met, it will often still be possible to secure the best outcome for the scheme while avoiding the need to issue a CN.

Illustrative examples

We consider that the examples below would not normally be materially detrimental to the likelihood of members receiving their accrued benefits, or meet the employer insolvency or the employer resources tests.

Discharge of scheme liabilities

The trustees of Scheme B have chosen to buy out pensioner liabilities by annuities. The trustees discharge the scheme liabilities through the purchase of annuities from a regulated insurer, so that the insurer assumes responsibility for making payments of members' benefits.

The trustees took proper account of members' interests in deciding to insure the scheme liabilities.

They reconciled the respective interests of different classes of member to ensure all are fairly treated and conducted due diligence when selecting a product and insurer.

General poor trading

Employer C has experienced poor trading as a result of market conditions.

Granting of security

Employer D grants security in the form of a first charge over some of its assets to renegotiate its borrowings with the bank.

In so doing, the employer engages with the scheme trustees and provides appropriate mitigation to the scheme for the reduction in covenant.


In contrast to the above examples, the following outline some actions that we consider do fall within the circumstances outlined in the code of practice - ie that could be the subject of a CN meeting the material detriment test, the employer insolvency test or the employer resources test.

In each of these examples, no or inadequate mitigation was provided to the relevant scheme.

Substitution of sponsor - sponsor support becomes nominal

Company E is moderately profitable and is a sponsor of a scheme with a large deficit.

The parent company which has no legal link to the scheme substitutes Company E with Company F, which is a shell company with no assets, as sponsoring employer.

Company E is sold off and the proceeds from the transfer pass directly to the parent company and its shareholders.

Disposal - sponsor support is reduced

Employer G transfers a profitable part of the business to another group company outside the employer covenant, resulting in a loss of half of the covenant.  The consideration due to Employer G is settled by the declaration of dividends to the parent company.

Transfer of scheme liabilities – sponsor support is reduced

Company H has transferred its employees and their respective pension liabilities to company I.

Company I is highly leveraged and offers a much weaker supporting covenant to the scheme than company H.

Restructuring – sponsor support is reduced

Employer J is the sole sponsor and owns Company K which generates substantial profits and holds significant property assets.  Employer J is part of a group owned by Company L.  Employer J transfers ownership of Company K to Company L as part of a group restructure.  The consideration owed to Employer J is settled by way of an intercompany debt which is unsecured, non-interest bearing and has no repayment date.

Manufactured insolvency – sponsor support is removed

The management team of an otherwise viable and solvent company, Employer M, took steps to manufacture its unnecessary insolvency to buy its business out of administration without the scheme. The scheme received an insolvency dividend, but the insolvency should never have occurred.

Increase in debt/prior-ranking security - weakening of scheme’s creditor position

As part of a group restructure, all companies within a corporate group agree to be responsible for the group’s increased borrowings. In particular, Employer N provides a new first-ranking charge over each of its main assets in support of the borrowed funds. Before this arrangement there had been limited security over any of Employer N’s assets. The restructuring provides no benefit to Employer N’s business.

Leveraged acquisition - weakening of scheme’s creditor position

Employer O is acquired by new owners, which subsequently raise a substantial amount of debt secured on O’s assets and business to finance a dividend to the fund.

Payment of unusual dividends to parent company – some instances of paying a dividend

Employer P pays a significant dividend to its parent company which is much larger than dividends paid in previous years and is greater than the company’s net profit generated during the same reporting period. 

It has a material impact on the employer’s covenant, as the dividend reduces:

a) the hypothetical recovery to the pension scheme on an insolvency of the employer and/or
b) the ability of the employer to meet the deficit recovery payments due in accordance with the prevailing schedule of contributions and/or
c) the employer’s ability to support the downside risks within the scheme’s funding and investment strategies

Unscheduled repayment of loan - payment favouring other creditors

Employer Q makes an unscheduled repayment of an intercompany loan when it is facing financial difficulty and has diminishing financial headroom

Appendix A: Glossary

Act. In the context of this code, an act also refers to a failure to act, or a series of acts and/or failures to act.

Employer covenant is the extent of the employer’s legal obligation and financial ability to support a DB scheme now and in the future – taking account, as applicable, of any guarantors or other contingent arrangements.

Jurisdiction means the jurisdictions of the United Kingdom. This includes England, Wales, Scotland and Northern Ireland.

Relevant time. For the purposes of the employer insolvency test, relevant time means the time when the act of failure to act occurred or, if over a period of time, at a time determined by us. In the case of acts that form part of a series, the relevant time means the time of the last act in that series. For the purposes of the employer resources test, relevant time means the time immediately before the act occurred or the failure to act first occurred, and in the case where the act or failure to act forms part of a series of acts or failures to act, the time immediately before the first of the acts occurred or the first of the failures to act first occurred.

Scheme means an occupational pension scheme14 other than a money purchase scheme15, a prescribed scheme, or a scheme of a prescribed description, for the purposes of section 38(1) of the Pensions Act 2004.

Scheme obligation has the meaning as described in legislation16.

Footnotes for this section

  • [14] See section 1 of the Pension Schemes Act 1993 (as amended)
  • [15] See section 181(1) of the Pension Schemes Act 1993 (as amended)
  • [16] See section 38A(5)

Appendix B: Corresponding Northern Ireland legislation

GB Legislation Corresponding Northern Ireland legislation
The Pension Schemes Act 1993 (c48) The Pension Schemes (Northern Ireland) Act 1993 (c49)
Section 1 Section 1
The Pensions Act 2004 (c35) The Pensions (Northern Ireland) Order 2005 (SI 205/255 (NI1))
Section 5 Article 4
Section 38 Article 34
Section 38A Article 34A
Section 38B Article 34B
Section 38C   Article 34C
Section 38D Article 34D 
Section 38E  Article 34E 
Section 38F  Article 34F 
Section 90  Article 85